Minimum Wage Act II: Options for strengthening the UK minimum wage A Resolution Foundation policy discussion paper James Plunkett, Tony Wilson and Conor D’Arcy February 2014 © Resolution Foundation 2014
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Contents
Executive Summary .................................................................................. 3
Chapter 1 – Today’s settlement ............................................................... 6
Chapter 2 – Strengths and shortfalls ..................................................... 11
Chapter 3 – Learning from different approaches .................................. 16
Chapter 4 – Elements of a bolder settlement ........................................ 22
Annex 1 – Low Pay Commission Terms of Reference ............................ 34
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Executive Summary
Fifteen years ago the UK introduced its first minimum wage into a hostile environment. The
House of Commons was divided over the policy and there remained a degree of trepidation even
among the policy’s supporters about its effects. Today, things are different. There is a confident
academic consensus that the minimum wage boosted earnings without causing unemployment,
and broad political support has followed. If the minimum wage debate has been maturing for
some time, it truly came of age in January 2014, when a Conservative chancellor said he not only
supported the policy but thought the rate should rise significantly.
The Chancellor's intervention did not come out of the blue. It follows a broader push for a
stronger minimum wage from leading thinkers on both right and left. This debate, a response to
the growing challenge of low pay, has secured the position of the minimum wage. But it has also
thrown the policy into flux. The minimalist settlement that served Britain so well for fifteen years,
in which the trusted Low Pay Commission (LPC) dispassionately recommends the rate each year
with little guidance or thought to the long-term, has run its course. This minimalist approach,
which was well-designed to respond to early opposition and uncertainty, seems less adequate
now that a consensus is secured and so much has been learned about the impact of the policy.
Yet so far politicians have been improvising and a formal new policy has not yet been put in place.
So what could it mean to more formally strengthen Britain's minimum wage and the architecture
of the Low Pay Commission? How could the policy be given renewed relevance for the next
fifteen years? This paper sets out a range of practical options. The ideas it presents try to manage
the tension inherent in any reform of Britain’s minimum wage. On the one hand, policymakers
need to protect what works well in today’s approach. The minimum wage, after all, is one of the
most effective policy reforms of the last thirty years. And at the heart of this success is the trusted
and evidence-led approach of the LPC.
On the other hand, much has changed since the current settlement was forged in 1998. After
fifteen years of research we have a much clearer insight into how minimum wages work. And
today’s challenge of low pay is itself a different beast to the one we confronted fifteen years ago.
At least one in five employees, and possibly many more, earn below £7.71 an hour, two-thirds of
the median wage and the standard definition of low pay. But recent data suggests only 9 per cent
of these low paid workers are on extreme low pay (below half the median) of the kind that a legal
wage-floor can easily address. Back in 1997, a third (32 per cent) of all low paid workers—7 per
cent of the total workforce—were on extreme low pay. Today’s frontline in the battle against low
pay is people who earn above the minimum wage but still too little to get by; this challenge may
be beyond the reach of today’s approach.
Other lessons have also been learned in the last 15 years. In some sectors, the minimum wage
has become the going rate. With little pressure to go beyond their legal obligation, some
employers have taken the NMW as a guide—something the LPC was clear it never intended.
While evidence suggests that many employers could afford to pay more, the NMW is inevitably
held back by the most vulnerable parts of the UK economy. And contrary to received wisdom, we
have also found that, for most of those who suffer it, low pay is not a temporary state that affects
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only the start of a career; three-quarters of low paid workers in 2002 had failed to fully escape
from low pay ten years later.1
When weighed against today’s challenge, three particular weaknesses of the 1998 settlement
stand out. First, the policy’s scope is narrow. The Low Pay Commission, despite its name, is in
effect a Minimum Wage Commission. This is not the LPC’s fault; despite its demonstrable
expertise, the body has never been asked to monitor overall low pay, assess its causes,
consequences or costs, or advise on policy to tackle it. This is in part because the government
more broadly has no explicit ambition to tackle low pay and no strategy to do so. Second, the
process for setting the NMW is short-term, but tackling low pay is clearly a long-term project. The
annual uprating of the NMW is unveiled each year just six months before it comes into force. This
creates uncertainty for business but also leaves the policy rudderless. It is hard to see how firms
can be expected to help deliver a future with less low pay, and how government can be expected
to support that goal, if neither knows where we are going.
Third, the LPC has only the blunt instrument of a single mandatory minimum wage at its disposal.
This has proven to be a highly effective tool against extreme low pay but it has been relatively
ineffectual against low pay more generally. The LPC has no powers to push or even encourage
employers to go further than the NMW when they can afford to. Indeed, discussions about
whether some parts of the UK economy could afford to pay more are out of keeping with the
LPC’s founding legislation. With little pressure on many employers to pay their lowest paid
workers more, this amounts to a strategy of ‘the minimum wage plus a penny’.
Of course any change to a body as successful as the LPC brings risks. But in light of these lessons
learned, and today’s different labour market environment, now is the right time to strike a new
and judicious settlement for the policy’s next fifteen years. To that end, this paper explores three
ways in which the minimum wage settlement could be strengthened. At this stage, we do not opt
for any one of these paths; each has strengths and weaknesses and this paper simply sets out
options. These options are under consideration in the Resolution Foundation’s ongoing review of
the future of the minimum wage, under the chairmanship of Professor Sir George Bain, the
founding chair of the Low Pay Commission. Final recommendations will be published next month.
First, we explore how the remit of the LPC could be broadened to make the body a genuine Low
Pay Commission. This might involve some simple additions to the LPC’s work, asking the body to
become experts on the scale, causes, costs and consequences of low pay, publishing regular
reports, commissioning research and advising the government on policy. This also raises the
difficult and much broader question of what measure of low pay should guide government policy
in general—for example, pay below two-thirds of the median wage or pay below the Living
Wage? And it also raises the question of what form the government’s ambitions on low pay
should take e.g. is there a need for a target and should it be set by politicians? We talk through
the pros and cons of the different options.
Second, we explore how the tool of the NMW itself could be made more ambitious, in
particular by giving more clarity over where it is heading in the medium-term. This would
reduce uncertainty but could also make the policy less passive, not only giving businesses the
1 Hurrell, A. Starting out or getting stuck? An analysis of who gets trapped in low paid work—and who escapes, Resolution Foundation (2013)
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notice they need to adapt, but also encouraging government to help them, for example through
employer taxes or skills policy. We explore three options: emulating the Bank of England’s
forward guidance approach; setting a political intention for the future value of the NMW; or
changing the current settlement entirely by raising the NMW by fiat over a number of years while
the LPC monitors effects.
Third, we explore whether the LPC could be given new powers and responsibilities to
complement the powerful but necessarily blunt tool of a single mandatory wage-floor. One
lesson from the last fifteen years is that a legal wage-floor is an effective but limited instrument.
We now know that the NMW’s effects did not ripple upwards and that, in some sectors, where
employers feel little other pressure to pay more, it has become the going rate. We consider
whether there are ways for the LPC to encourage employers in some parts of the economy to pay
more when they could afford to. One approach would be for the LPC to publish ‘reference rates’
for the wage-floor that firms in key sectors could afford to pay. The same could be done in
London. Ideas like these are out of keeping with the minimalism of the LPC’s founding legislation.
This tells us more about deals that were struck 15 years ago than about the challenge of low pay
we face today.
Taken together, these types of reforms would mean a broader, more confident and assertive
approach to the minimum wage. However, they each have advantages and disadvantages that
need to be weighed up. The Resolution Foundation’s review is considering these ideas among
others and will publish its final report with full recommendations next month.
Outline of the paper
- Chapter 1 starts by taking stock of the role and functions of the LPC today, talking through
how the body’s founding legislation, governance arrangements and remit guide the tone
and rhythm of its work.
- Chapter 2 reflects on the strengths and shortfalls of today’s NMW settlement. It reaffirms
how successful the LPC has been at establishing the principle of a minimum wage. But it
also shows how the current settlement falls short of what is needed in the next 15 years.
- Chapter 3 learns lessons from the strategies that are used in other areas of economic
policy. From fiscal policy to monetary policy to policy on skills and migration, a range of
different approaches are taken, many broader and more assertive than our current
strategy on low pay.
- Chapter 4 applies these lessons to the architecture of the LPC. It looks at how the LPC
could be strengthened in three respects: by broadening its work into a genuine Low Pay
Commission, by giving more clarity on where the NMW is heading in the medium-term,
and by giving the LPC additional tools to help encourage employers to pay more.
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Chapter 1 – Today’s settlement
Before evaluating the strengths and weaknesses of Britain’s minimum wage, it is useful to take
stock of how the approach works today. Here we talk through the roles and functions of the LPC,
taking the body’s legislative underpinnings, governance arrangements and work plan in turn. In
the next chapter we weigh up the strengths and weaknesses of this policy architecture.
The Low Pay Commission
The Low Pay Commission was established in 1998 to support the introduction of the UK’s first
National Minimum Wage. In technical terms, the LPC is a non-Departmental Public Body (NDPB)
and as such it operates within both statutory and delegated authorities. The LPC derives its legal
status from the 1998 National Minimum Wage Act and it derives its delegated authority to
recommend the rate of the NMW from its sponsoring Department - the Department for Business,
Innovation and Skills (BIS) - with the Secretary of State for BIS deciding whether or not to accept
the rate that the LPC recommends. These delegated authorities are set out in its Terms of
Reference. To understand how the LPC goes about its work, we need to understand these
underpinning governance arrangements.
1. Legislative underpinnings
The National Minimum Wage Act defines the work of the LPC in a number of important respects.
It established the LPC to advise the Secretary of State on several aspects of NMW policy:
The hourly rate of the NMW
How the hourly rate should be defined (i.e. what is and is not included)
Whether a different rate should be applied for younger people and what that rate should
be, and (within tight limits) other classes of people to whom a different NMW should be
applied.
The Act only required the Secretary of State to seek the LPC’s advice on the first level of the
NMW, but also included powers to “at any time refer to the Low Pay Commission such matters
relating to this Act as the Secretary of State thinks fit”. In practice this has meant that each year
since April 1999 when the first NMW came into force, the Government has sought the LPC’s
advice on the level of the NMW as well as its advice on matters relating to enforcement and the
fit between the NMW and other policies or practices. Aside from two exceptions, when the
government rejected the LPC’s recommendation to start the adult rate at age 21 and instead
started it at age 22 and when it rejected its recommendation to freeze the apprentice rate in
2013 and instead increased the rate by 1 per cent, the government has always accepted the LPC’s
advice.
The 1998 National Minimum Wage Act also establishes the composition of the LPC. It requires
that the LPC consist of a chairperson and eight members, with an appropriate balance between:
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“(a) members with knowledge or experience of, or interest in, trade unions or matters
relating to workers generally;
(b) members with knowledge or experience of, or interest in, employers’ associations or
matters relating to employers generally; and
(c) members with other relevant knowledge or experience.”
In practice this has meant an LPC composed of three trade union representatives, three employer
representatives, and three independent members, including the chairperson. These independent
members have usually been academics. In addition to this, the LPC has eight permanent civil
servant staff.
The 1998 Act is narrow in scope, focusing the LPC on the level and application of the NMW. In
practical terms, it means that the legislative reach of the LPC does not extend beyond the NMW
to the problem of low pay more generally. The Secretary of State has no specific legislative
authority to refer matters to the LPC that do not relate to the level of the NMW and its
application (i.e. those matters covered by the National Minimum Wage Act).
In some cases, this limited scope prompts the LPC to diverge from standard approaches to low
pay. For example, the term ‘low pay’ is used in the LPC’s work to mean pay around or below the
level of the Minimum Wage. This definition has also been picked up by other official UK bodies,
such as the ONS in its annual ‘low pay’ report.2
This is markedly narrower than standard definitions of ‘low pay' used by other agencies both in
the UK and internationally. For example, the focus of the ONS’s report ‘Low Pay’ is the 279,000
jobs that are paid below the NMW. Similarly, the LPC estimates that in the region of 5 per cent of
the UK workforce earn around the NMW. By contrast, the OECD definition of low pay—hourly pay
below two-thirds of the median wage—covers at least 21 per cent of the UK workforce.
The 1998 NMW Act also in effect prohibits greater variation in the NMW beyond the categories of
young people or people in the first six months of a new job. The Act states that:
“No amendment [to the NMW] shall be made […] which treats persons differently in
relation to—(a) different areas; (b) different sectors of employment; (c) undertakings of
different sizes; (d) different ages over 26; or (e) different occupations.”
Since the LPC’s work is focused tightly on the NMW, this in effect means it is beyond the scope of
the LPC to consider whether different parts of the economy could bear a higher wage-floor. The
two exceptions to this—workers under the age of 26 or those in the first six months of
employment—are written into the legislation on the grounds that these groups might justify a
lower rather than a higher rate.
2 Low Pay, April 2013, Office for National Statistics
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2. Governance arrangements
In addition to this founding legislation, the LPC’s work is shaped by its governance arrangements.
These include its Terms of Reference and the annual remit the body receives from the
government. The LPC’s Terms of Reference are included in Annex 1. These describe how it will
exercise its statutory powers through research, evidence-gathering, and the functioning of the
Commission. They also define the LPC’s purpose as:
“to recommend levels for the minimum wage rates that help as many low-paid workers as
possible without any significant adverse impact on employment or the economy.”
This formulation—to find the highest NMW that does not cause sufficient adverse impacts—is a
delegated rather than statutory authority. It is set by Government rather than by Parliament so
changing it would not require primary legislation. However, it has remained essentially
unchanged since the LPC’s first Terms of Reference were set in 1997.
The LPC’s activities are further defined in its remit from Government. This remit is usually set
annually, and generally asks the LPC to:
“Monitor, evaluate and review” the levels of the NMW rates and to recommend levels for
the following year;
Review or consider the implications for the NMW of any relevant policies, practices or
reforms. In recent years this has included regulations on salaried hours workers, the
treatment of accommodation costs, and proposals to abolish the Agricultural Wages
Board; and
Take account of wider factors as appropriate—including for example the state of the
economy, tax and benefit reforms and other changes.
The LPC’s annual remit has lately focused on the position of young people, with the last two
remits requesting the LPC to “review the contribution the NMW could make to the employment
prospects of young people”. Through this wording, the LPC has in effect been asked to advise on
whether the NMW could be set so as to improve employment rather than advising on the highest
rate that could be achieved without damaging employment. In the past, the LPC has also been
asked to look at wider issues such as the persistence of minimum wage work and the adequacy of
the NMW when considered alongside state support. But having been posed in the LPC’s annual
remit, rather than as reforms to the NMW Act or the LPC’s permanent Terms of Reference, these
issues have been explored as one-offs rather than becoming core parts of the LPC's work.
3. Month-to-month work plan
The LPC’s founding legislation and governance arrangements in effect prescribe an annual cycle
of activities: the LPC receives its yearly remit, undertakes a research programme into the effects
of the NMW, takes evidence in writing and orally, carries out analysis and produces a report with
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recommendations. This annual cycle has not changed since its inception. It plays a strong role in
shaping the content of the LPC’s work through the discussions, research, and evidence-gathering
that it carries out.
Figure 1: the annual cycle of the Low Pay Commission
The LPC’s annual Remit is usually issued in June, before the summer Parliamentary Recess, with a
requirement to report by the end of February. This gives nine months to complete the cycle, with
the commissioning of research and consultation over the summer, evidence sessions held in the
autumn, and evidence assessed and findings agreed in the autumn/winter. The LPC’s
commissioners are highly engaged in this process, making visits to employers and discussing at
length the latest academic evidence. Because of the tasks it is set, the LPC has come to focus its
work on assessments of the historic effects of the NMW and on how the immediate economic
outlook might affect the prospects for a higher rate the subsequent year. Typically the new rate of
the NMW is unveiled in March or April and comes into force on October 1st.
The research commissioned by the LPC focuses on the direct effects of the NMW on a range of variables and is mostly technical in nature. Recent examples include:
An assessment of the impact of the NMW on low paying companies3
An assessment of the impact of introducing the apprentice rates4
An assessment of the NMW on the domiciliary care sector5
In its first fifteen years of operation, the LPC has commissioned over one hundred independent
reports, the vast majority of which have been focused on an assessment of the impacts of the
3 Riley, R. and Rosazza Bondibene, C. (2013) “The impact of the national minimum wage on firm behaviour during recession” National Institute of Economic and Social Research 4 Higton, J. et al (2012) “An Assessment of the Introduction of the Apprentice Rate”, ipsos MORI and Cambridge Policy Consultants 5 Bessa, I. et al, (2013) “The National Minimum Wage, earnings and hours in the domiciliary care sector”, University of Leeds
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NMW. This constitutes one of the best bodies of evidence on the impact of minimum wages
anywhere in the OECD. It has centred mainly on the variables of earnings, employment and
unemployment and working hours, with additional work carried out on the effects on profits,
prices, productivity and business closures.
While the focus of the LPC’s research has not changed significantly since it was established, the
academic context is now very different. The LPC’s early work broke new ground, revealing for the
first time the effects of a wage-floor in the UK. This was not least because the overnight
introduction of the NMW, and its large early up-ratings, provided a useful natural experiment for
economists to investigate. Today’s research more often refines established findings.
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Chapter 2 – Strengths and shortfalls
The short biography of the LPC provided in Chapter 1 shows how the settlement designed in 1998
continues to shape the tone and rhythm of the body’s work. This chapter reflects on some of the
key strengths of that approach, as well as the shortfalls that stand out when it is weighed up
against today’s challenge of low pay.
Strengths of the current settlement
The approach that was outlined in Chapter 1 is clearly minimalist in the way it conceives of the
NMW and low pay, and in the way it thinks about setting the NMW and researching its impacts.
As one might expect, this minimalism has proven to be a sensible way to establish the NMW as a
new policy given the controversy and opposition it faced upon its introduction. It undoubtedly
enabled the LPC to deliver on the tasks for which it was designed. The system has had some
particular strengths in the NMW’s first 15 years:
It depoliticised the process of setting the NMW, helping to replace the division of the late
1990s with the consensus the policy enjoys today. This success is most obvious when
Britain’s experience with the NMW is compared with that of the US Federal Minimum
Wage (FMW). The FMW, which can only be raised by an Act of Congress, remains highly
divisive politically. Most recently, the US President has had to resort to raising the FMW
for federal contractors only—something within his executive authority—for want of the
ability to raise the rate for minimum wage workers not employed on public contracts. In
the UK, the LPC has helped to ensure a much cooler debate.
It secured the buy-in of the businesses and unions through taking a social partnership
approach. The LPC has reached a unanimous view from its employer- and union-
members in every report it has produced, including throughout the difficult economic
environment since 2008. Despite the contentious nature of the minimum wage and the
wide range of opinions that feed into the LPC’s deliberations, there has been little
sustained criticism of the LPC’s judgements after they are made.
Its process for annually uprating the NMW gave the LPC flexibility to adapt to changing
economic times. Again, this stands in marked contrast to the US’s experience. Figure 2
shows how the US system has raised the FMW rarely and abruptly, increasing uncertainty
for both workers and employers. The UK NMW has risen much more smoothly.
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Figure 2: Comparing the UK and US national and federal minimum wages
US$ PPP per hour Percentage of median full-time wage
Source: Resolution Foundation analysis, OECD Stat.
The UK’s approach also contrasts with countries that index their minimum wage to prices.
In France, for example, where the minimum wage is linked to a measure of the cost of
living, increases have been steadier but also less responsive to labour market conditions.
The UK’s LPC set a low NMW at first, then ambitiously increased the rate faster than
inflation for a number of years in the early and mid-2000s. This was followed by below
inflation increases from 2008 to 2013. Had the NMW instead been tied to inflation, the
result would have been an NMW which rose more slowly in good times and more quickly
in difficult times. The LPC’s method has allowed for a much more responsive approach.
The LPC has built from scratch a UK evidence base around the minimum wage, with a
robust and objective commissioning process to minimise disagreement about the facts.
This research has transformed our understanding of the impacts of wage-floors and the
operation of low wage labour markets. Research commissioned by the LPC has shown, for
example, that employers have adapted to the NMW through channels other than
employment, adjusting profits, wage distributions, pricing and productivity rather than
reducing employment.6 It has also helped us to understand which parts of the labour
market are more vulnerable to a higher NMW, for example young workers, care homes
and women in part-time employment. There is even evidence that the UK minimum wage
literature is more objective than the US literature, with statistical analysis revealing
publication bias in the US literature— that is, studies are more likely to be published if
they find a negative impact from the minimum wage.7 This is not found in the UK
6 Plunkett, J and Hurrell, A. Fifteen Years Later: A discussion paper on the future of the UK National Minimum Wage and Low Pay Commission, Resolution Foundation (2013) 7 Doucouliagos H. and Stanley T.D. (2009) “Publication Selection Bias in Minimum-Wage Research? A Meta-Regression Analysis”
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literature, perhaps partly because of the central role the LPC has played in commissioning
neutral research.8
Shortfalls of the current approach
Alongside the strengths of Britain’s current minimum wage settlement, there are a number of
ways in which the architecture of the LPC falls short in its response to the challenge of low pay.
Rather than being a failure of the LPC itself, this reflects the fact that the LPC has done what was
asked of it 15 years ago. While it is important to note that the NMW and the LPC as a body can
only ever be one part of efforts to reduce low pay, it is clear that the world has changed a lot
since the policy’s introduction, not least because of the NMW’s success. Looked at afresh today, a
number of shortfalls stand out:
The first and most obvious shortfall is the narrowness of the LPC’s work. The LPC would more
aptly be called a Minimum Wage Commission, focused on the specific technical question of the
appropriate level of the legal wage-floor. The LPC concentrates overwhelmingly on assessing the
impact of the NMW, which at £6.31 covers at most 5 per cent of the workforce. This is a far
smaller share than the 21 per cent of the UK workforce that is low paid under the official
definition, the threshold for which is around £7.71 hour, a number that might itself be a large
under-estimate.9
In the late 1990s, the LPC’s focus on extreme low pay made sense. In 1997, 7.0 per cent of the
entire UK workforce suffered extreme low pay, being paid below half the median wage. This
population, prime targets for the NMW, made up 32 per cent of the workers who were low paid
(being paid below two-thirds of the median wage). Extreme low pay was therefore a good place
to start the battle against low pay more generally. In latest figures, by contrast, only around 1.9
percent of the UK workforce faces extreme low pay, the vast majority of whom are teenagers or
apprentices, the remainder representing illegal avoidance of the NMW. This is 9.2 per cent of
today’s low paid workforce. The vast majority of low paid workers are now in the region above
the NMW but below the low pay threshold of around £7.71 an hour.
The LPC’s narrow focus is just one symptom of the fact that the UK government does not have an
explicit ambition or objective of economic policy to tackle low pay. No part of government is
tasked with monitoring low pay, investigating its causes and consequences or advising ministers
on steps that could be taken to tackle low pay. Moreover, the government has no overall view on
what it is trying to achieve with regard to low pay and no strategy guiding its approach. As the
problem of low pay has grown, other agencies, most notably the Social Mobility and Child Poverty
Commission, have improvised in this space, exploring low pay in an ad hoc fashion. No institution
has however been formally tasked with undertaking such a role.
8 Linde Leonard, M. Stanley T.D. and Doucouliagos, H. (2013) “Does the UK Minimum Wage Reduce Employment? A Meta-Regression Analysis” 9 Analysis in the IFS’s Green Budget places the proportion of low paid people at 29 per cent. The different estimates are a result of the use of two datasets, the Annual Survey of Hours and Earnings used in this paper and the Labour Force Survey to which the IFS’s figure refers.
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The second apparent shortfall of Britain’s current approach to low pay is the short-termism of
the minimum wage itself. Neither the government nor the LPC has any view on where they hope
or expect the NMW to be in the medium-term. This sits uncomfortably when we know that
tackling low pay will be a long-term task. It also has practical costs. It means, for example, that
each year the NMW is unveiled just six months before it comes into force, creating uncertainty for
employers, when in other areas of economic policy it is now standard practice for the
government to give foresight about its intentions.
The lack of direction for the NMW also makes the policy inherently passive. The LPC is tasked
with describing the UK labour market as it sees it today, with all its current constraints. This has
consequences for how employers respond: how can they be clear on their role in reducing low
pay if they have no sense of where the minimum wage is going? And it has implications for the
LPC’s relationship to government. For example, the LPC does not advise the government on steps
it could take to make a higher NMW possible in future, only on the NMW that can safely be
introduced today.
Of course the short-termism of the NMW reflects the difficulty of setting a wage-floor in advance.
But as we will see in Chapter 3, there may be ways to balance this need for flexibility while also
giving more clarity about future intentions. And again, it is interesting that Whitehall has already
improvised an ad hoc response to this problem. The Chancellor’s recent intervention, supporting
the idea that the NMW could rise significantly to restore the value it has lost in recent years, fed
into the LPC’s annual process of recommending the level of the NMW while not binding the LPC’s
hand. Yet it fed in unexpectedly just a month before the LPC was due to make its annual decision.
With the NMW having fallen in real terms for five years running, the government feels
understandable pressure to make clear that this value will be restored as an economic recovery
takes hold. But there is not yet a formal policy process for giving this guidance or direction.
Third, the LPC only oversees the single tool of the mandatory national minimum wage. In the
past fifteen years the effectiveness of this tool has become clear but so have its limitations. When
the NMW was introduced a key concern was that its effects would ripple upwards, pushing up
wages across the economy and causing inflation. The opposite problem has transpired. The NMW
has had such a limited ripple effect that workers now cluster at the NMW, making the minimum
wage the going rate in some sectors. As Figure 3 makes clear, the lack of pressure points above
the NMW has left the UK labour market increasingly bottom heavy, with a large number of
workers paid at or around the legal wage-floor.
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Figure 3: Before and after the National Minimum Wage
Distribution of gross hourly pay excluding overtime in the UK in 1997 and 2012
Notes: Gross hourly pay excluding over-time Source: Resolution Foundation analysis, Annual Survey of Hours and Earnings
The LPC has neither the power nor responsibility to do anything to encourage employers to go
beyond their legal obligation to pay the NMW. In effect, the LPC and the government takes a
‘minimum wage plus a penny’ approach, focusing only on the level of the NMW and its
enforcement. Because further variations in the structure of the NMW are prohibited in the NMW
Act, any conversations about whether some parts of the economy could afford to pay more are
entirely out of keeping with the way the LPC’s work has been framed.
Summary
The strengths and shortfalls of today’s NMW settlement represent a system that was well-
designed for the world of 1998 and carefully negotiated to reflect political pressures at the time.
In its narrowness, short-termism and singular reliance on the NMW, the LPC provides only a
minimalist contribution to the fight against extreme low pay. In the next chapter, we explore case
studies of how other bodies with different functions related to economic policy take a broader,
more assertive approach and ask what, if any, lessons could be learned.
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Chapter 3 – Learning from different approaches
The government has established a number of independent bodies to advise it on key aspects of
economic policy. In this chapter we look at four of these examples to draw lessons for what a
bolder LPC could look like. We consider:
The Office for Budget Responsibility’s work on fiscal policy
The Monetary Policy Committee’s work on monetary policy
UK Commission for Employment and Skills’ work on skills policy
The Migration Advisory Committee’s work on migration policy
These bodies obviously have very different responsibilities and powers from the LPC, and from
each other, each striking a different balance on key policy trade-offs. What, if any, lessons do they
hold for what a stronger LPC could look like?
1. The Office for Budget Responsibility
The Office for Budget Responsibility (OBR) was established under the 2011 Budget Responsibility
and National Audit Act “to examine and report on the sustainability of the public finances ...
including through forecasting, long-term projections and balance sheet analysis”. Its two key
functions are to publish economic and fiscal forecasts at key fiscal events (Budgets and Autumn
Statements); and at the same time to assess the government’s progress against its ‘fiscal
mandate’ of achieving a balanced current budget (cyclically-adjusted) within five years.
While the OBR’s forecasters have struggled in a highly unpredictable economic climate, there is a
political consensus that the body has earned its place, improving the quality and independence of
the advice government receives on fiscal policy. Just four years in to the OBR’s life it already feels
highly unlikely that its role would be removed.
Because of the way the OBR has helped the government deliver on a clear and contentious
objective of economy policy, it carries some interesting lessons for what a more assertive LPC
could look like.
First, while the OBR’s judgments are independent, its work is based on a clear political objective
that is defined by a target (the fiscal mandate). This target requires that the government always
has in place a plan to eliminate the structural deficit. This is an interesting example of how a
target can give a clear trajectory but not tie hands. It focuses minds and gives direction while
retaining flexibility. Indeed the government’s main fiscal target has come into criticism for being
too flexible. The rolling timetable only requires that there be a plan to eliminate the structural
deficit, not that the deficit in fact be eliminated. These debates echo the tensions inherent in
giving a sense of direction on low pay or the minimum wage. It is also interesting that the
government’s clear objective on fiscal policy makes the relationship with the OBR far more pro-
active. Its judgments drive policy changes in a much a broader way than the LPC.
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Second, the OBR combines its main publications at key fiscal events with a longer-term
programme of in-house research. Its biannual statements run alongside a Fiscal Sustainability
Report, which diagnoses the long-term prospects for the public finances. Examining the path of
spending and revenues over the next 50 years, this is by nature an ambitious and uncertain piece
of research. Despite this, few experts have questioned its worth. The OBR also publishes a range
of work that stands aside from its annual process: Briefing Papers for technical audiences;
Working Papers diving into specific issues; Discussion Papers to invite views; and Occasional
Papers to provide ad hoc advice to parts of government at request.10 This is a different approach
to the LPC, less focused on one task, more dependent on internal work, and broader in scope.
Third, the OBR’s track record suggests that a new body can establish legitimacy in a contentious
area of economic policy even if it is composed of experts. The five members of the OBR’s
Oversight Board are economists, not representatives of interest groups, making the OBR a council
of experts rather than a social partnership body. While the OBR has taken criticism, its
impartiality has not been widely questioned. There may be good reason to think that setting a
minimum wage is a different task, requiring social partnership, but the OBR reminds us that well-
chosen experts can gain legitimacy while working on a difficult and highly contentious area of
economic policy.
Overall, the OBR is an interesting example of how the government can balance a clear medium-
term political objective but be guided in achieving that objective by an independent body. The
government’s rolling primary deficit-reduction target has given a sense of direction and
momentum to fiscal policy without tying the government’s hands as economic conditions change.
And the OBR’s broad and credible research agenda, backed by expert advisors, has brought
accountability and evidence to the process.
2. The Monetary Policy Committee
The Bank of England’s MPC offers different insights for the LPC. While not formally an NDPB, the
MPC has similar characteristics and performs comparable functions. It was established in
legislation in the Bank of England Act 1998, which also gave the Bank of England responsibility for
monetary policy with the objective “(a) to maintain price stability, and (b) subject to that, to
support the economic policy of Her Majesty’s Government, including its objectives for growth
and employment.”11
One lesson from the MPC is the way its bounded inflation target balances a clear political goal
with flexibility, in similar fashion to the OBR. The Bank has a clear mandate on price stability but
the government reserves the power to define the inflation target.12 This target sets a clear
intention despite being backed only by the weak accountability mechanism that the Bank of
10 Two Occasional Papers have been published to date, on oil revenues and Scottish taxation. 11 The Bank of England Act 1998, s.11 12 Initially this was defined an inflation rate of 2.5% on the Retail Prices Index (excluding mortgage interest) and later a rate of 2.0% on the Consumer Prices Index.
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England Governor is required to write a letter when the target is missed by more than one
percentage point.13
Second, the MPC’s recent experiment with forward guidance, for all the criticism it has attracted,
was a serious attempt to increase clarity about the direction of travel in an uncertain area of
economic policy. Since 2013, the MPC has had a formal mandate to trade off growth and
potentially higher inflation, and the government explicitly noted (in the MPC’s 2013 remit) that:
“The Committee may also judge it to be appropriate to deploy explicit forward guidance
including intermediate thresholds in order to influence expectations and thereby meet its
objectives more effectively.”
The main lesson from this experiment is how difficult it is to balance clarity and flexibility. The
Bank’s initial response to this remit14 was to say it would not consider raising interest rates until
unemployment fell below 7 per cent (while medium-term inflation prospects or financial stability
were not at risk). The Bank has now broadened this criterion to include a full basket of indicators
of spare capacity. Some say the policy has done little to increase certainty about the path of
policy15 though the Bank itself claims that the policy has helped to increase confidence over the
future path of interest rates.16 The approach raises the question of whether the LPC could be
clearer about the conditions in which it would raise the NMW ambitiously in the recovery, or
whether this would struggle to increase certainty.
Third, the MPC’s position in the wider of Bank of England shows how a tightly defined technical
committee can sit within an organisation with much broader responsibilities. The MPC long ago
established itself as being legitimate in its own right, and it is hard to imagine now an approach
which located monetary policy either back in the hands of politicians or outside the Bank of
England. And the MPC’s work is not confused by the fact that it sits within the broader BoE. This
is a useful lesson, raising the possibility that the NMW-setting process, and its social partnership
model, could be quarantined within a broader LPC with new resources, powers and
responsibilities.
Fourth, the MPC again shows the degree to which an expert body can operate successfully while
overseeing a highly contentious issue. Despite the controversial nature of the decisions the MPC
takes, its members do not pretend to represent the interest groups impacted by these judgments.
While the substance of its decisions is hotly contested, the legitimacy of the MPC’s decisions or
its authority to make them is not in question. Again, while there are strong reasons to protect the
social partnership model of the LPC, this may suggest that not all aspects of the government’s
work on low pay need to pass through the clearance process of the nine-member social
partnership body of the current LPC (or that social partnership involvement in low pay issues
should be limited to the NMW setting process).
13 When inflation remains outside this range of 1-3%, then letters should be sent every three months. 14 http://www.bankofengland.co.uk/publications/Documents/inflationreport/2013/ir13augforwardguidance.pdf 15 http://www.ft.com/cms/s/0/31609b0a-1af1-11e3-87da-00144feab7de.html#axzz2hhbepuSA 16 http://www.bankofengland.co.uk/publications/Documents/inflationreport/2013/ir13augforwardguidance.pdf
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In summary, the MPC reminds us again that there are different ways for policy to balance clarity
and flexibility. The LPC settlement again looks minimalist and short-termist, even by contrast to
the highly flexible model of the MPC. It is also notable that the Bank and MPC have become more
assertive as conditions have changed while the LPC still works on a model designed in 1998. This
is interesting given that the balance of concern between growth and inflation has shifted in a
similar way to the balance of concern between unemployment and wage growth.17
3. The UK Commission for Employment and Skills
The UK Commission for Employment and Skills (UKCES) applies a very different model. It was
established in 2008 in response to the Leitch review of UK skills policy18 and works to raise
employer investment in skills. Rather than just advising government or holding ministers
accountable, it works actively to change employer behaviour. It uses a variety of tools to work
towards this. UKCES:
- Exerts moral and reputational pressure on employers by developing standards and
frameworks (e.g. for apprenticeships);
- Forecasts the supply and demand of skills in the UK economy;19
- Directly invests public money in (usually co-funded) programmes to encourage
employer-investment in skills;20
- Commissions employer surveys and shares the data with researchers;21
and
- Uses its own Commissioners as advocates.
The main lesson from the work of UKCES is that a variety of tactics can be used to change
employer behaviour. This is a far wider set of activities than those undertaken by the LPC, not
least because UKCES has over 10 times more staff than the LPC (see Table 1). UKCES also feeds
into policy in a wider range of areas, from the design of youth employment programmes to
changes to skills funding. UKCES has taken on this more activist role over time.
Another interesting pointer from UKCES lies in the way it convenes employers, providing a neutral
space outside government in which employers can meet to address collective action problems.
UKCES is overseen by a team of thirty commissioners, the majority (eighteen) of whom represent
employers, with four places held by trade union representatives. Commissioners meet every
three months and contribute between meetings through events and other activities. It is notable
that there is no equivalent body to convene employers on the issue of low pay, especially in light
of its common causes within particular sectors. It is fair to say, however, that the UKCES operates
in an area that is less controversial for social partners to support.
17 Gregg P. and Machin S. (2012) “What a drag: the chilling effect of unemployment on real wages,” Resolution Foundation 18 Leitch, S. (2006) “Prosperity for All in the Global Economy: World Class Skills” 19 Wilson, R.A. and Homenidou K. (2012) “Working Futures 2010-2020: Main Report” 20 Employer Ownership of Skills pilots, as well as through a Growth and Innovation Fund and Employer Investment Fund 21 Employer Skills Survey, Employer Perspectives Survey
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4. The Migration Advisory Committee
Finally, it is worth touching on the work of the Migration Advisory Committee (MAC). The MAC is
useful as an example because it works in a similar area of labour market economics to the LPC.22
The MAC was established in 2007 alongside a new points-based system to shift the balance of
migration towards groups with the most to contribute to the UK economy. The MAC’s focus has
changed over time from advising on skills shortages among specific occupations to studying policy
impacts, including limits on migration.
The MAC’s work is useful when weighing up whether the LPC could feasibly take on more difficult
judgments, particularly over the sensitivity of different parts of the UK labour market to a higher
NMW. It carries out extremely detailed modelling to identify gaps in the UK labour force that
could be filled by migration. It does this by maintaining the Shortage Occupation List or the Codes
of Practice, a thorough list of occupations in which the UK has skills shortages, calculated both
through academic work and in consultation with a wide range of stakeholders. Despite its
complexity the MAC’s work has not received significant push back. The MAC’s five members,
including the chair, are independent academics while representatives from the Home Office and
UKCES also attend and the work is supported by a secretariat of 10 civil servants. This suggests
that it might be possible for a broader LPC to take more work without necessarily becoming a far
more complex body.
Table 1: Comparing the capacity of bodies on economic policy
Budget and staff of advisory economic non-departmental public bodies
Funding Permanent staff Commissioners or
Board members
Low Pay Commission £827,000 8 9
Office for Budget Responsibility £1.75m 11 5
Monetary Policy Committee N/A N/A 9
UKCES £19.2m* 97 30
Migration Advisory Committee £796,000 12 5
Notes: * Excluding programmes
Summary
Looking at how these other institutions do their work reminds us that there is more than one way
to design a body like the LPC. It also helps to dampen fears that any reform of the LPC will
inevitably break the current settlement. There are ways to design policy to give more clarity over
the direction of travel, even in uncertain economic environments, while retaining flexibility.
22 Metcalf, D. (2013) “Immigration and the British Labour Market: The role of the Migration Advisory Committee”
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Independent advice can be maintained even when the government is very clear about what it is
trying to achieve. It is also clear that legitimacy can be won through expertise and there are
benefits to both social partnership and expert led processes. And other tools can be utilised to
influence employer behaviour far beyond those used by today’s LPC.
In the final chapter we look at how some of these lessons could be applied to our approach to
low pay, forging a broader and more assertive settlement. Rather than recommending particular
reforms, we set out the menu of options that is being considered by the Resolution Foundation’s
ongoing review of the future of the NMW and LPC.
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Chapter 4 – Elements of a bolder settlement
This paper has evaluated the UK’s current minimum wage settlement. For a sense of how other
institutions work we have also looked at case studies across a range of economic policy areas. In
this chapter we draw on these studies to sketch out some practical options for how today’s
minimum wage settlement could be strengthened. The areas we discuss link to the shortcomings
that were outlined in Chapter 2. Each has its pros and cons and we set out a range of options
rather than recommending any particular reform.
First, we explore how the LPC could be broadened into a more genuine Low Pay Commission.
The practical elements of a broader LPC could be uncontroversial: writing annual reports on the
incidence of low pay, conducting research into its causes, consequences and costs, and advising
government on policy that affects low pay. But asking the LPC to help the government achieve a
broader objective on low pay also raises a question: what measure of low pay should drive
government policy and what form should this objective take? The different options, for example
tackling pay below the Living Wage, have quite different implications for policy. We talk through
the pros and cons of different approaches.
Second, we look at how the government, or the LPC itself, could give more clarity over where
the minimum wage is heading in the medium-term. This is inevitably a balancing act. Giving too
much clarity would mean asking the LPC to do the impossible and would also tie the body’s hands
even as labour market conditions change. Yet, as we have seen, and as the Chancellor implicitly
acknowledged in his recent statement, today’s settlement is rudderless, giving no sense of where
the NMW is headed. As a result it is also passive, describing the UK labour market as it is today
rather than trying to change it. Improving on these shortfalls without undermining the flexibility
or independence of the LPC is a difficult challenge but is far from impossible. We apply some
lessons from the MPC and OBR to set out a spectrum of potential reforms that range from the
modest to the more assertive.
Third, we look at whether the LPC could be given additional powers and responsibilities to
complement the impact of the NMW. Because of the inevitable bluntness of a single mandatory
minimum wage, additional tools are likely to be needed to tackle the broader problem of low pay.
Some will of course fall to other parts of government. But the LPC may be well-placed to lead on
others. For example, we know that the minimum wage is to some extent an ill-fitting garment: it
pinches hard in some parts of the economy even while many other employers could afford to pay
more. This simplicity is a real strength and there are big downsides to fragmenting the mandatory
NMW. We look instead at whether the LPC could complement the NMW by publishing an
assessment of a non-binding ‘affordable wage’ that employers in certain parts of the economy
could pay, whether in specific sectors or in a distinct economy like London.
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1. Options for making the LPC a genuine Low Pay Commission
We start by considering how the LPC could be given a broader remit to tackle low pay. This would
extend its work significantly beyond the NMW, which covers at most around 5 per cent of the
workforce, to consider the 21 per cent or more who are low paid. Drawing on the work of other
bodies, some of these additional roles could include:
- Publishing an official annual assessment of the incidence of low pay across the UK
economy, mapping low pay by sector, gender, age and region;
- Conducting or commissioning deeper research into key features of low pay, such as its
persistence over time, its extent in certain occupations or industrial sectors, or its
relationship to gender;
- Conducting, commissioning or drawing together evidence on what works in tackling low
pay, and working with government and social partners to share and build on this
evidence-base;
- Advising the government on the design of policy that effects low pay, for example welfare
reform, skills and progression; and
- Convening employers in key sectors to discuss what it would take to reduce the incidence
and persistence of low pay.
While these activities would extend the remit of the LPC significantly, and no doubt raise
questions of resourcing, they do not fundamentally alter the nature of the LPC’s work and would
go with the grain of approaches taken in other areas of economic policy. They could also help to
shift the conversation around the NMW and low pay to a more proactive footing.
A more difficult question raised by this broader remit is: how do we define low pay and what
should the government be trying to achieve? This comes down to the question of what specific
measure of low pay should drive government policy and what form this objective should take.
There are two prominent options when it comes to measuring low pay: aim to reduce the share
of people paid below the Living Wage or reduce the share of people paid below two-thirds of the
median wage. Figure 3 shows trends in low pay on the two measures. In practice, the results are
similar: the Living Wage from November 2013 is £7.65 an hour outside London while two-thirds
of the median wage (from April 2013 data) is £7.71. The share of workers earning below each is
therefore also similar. But it is important to understand that, despite this apparent similarity, the
two measures are nonetheless fundamentally different and will almost certainly diverge sharply
in coming years.
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Figure 4: Incidence of low pay in the UK
Source: Resolution Foundation analysis, Annual Survey of Hours and Earnings
The Living Wage (LW) is now almost certain to diverge sharply from the official measure of low
pay because of the way it is calculated (see Box 1 for full details). In simple terms, the LW is the
wage needed to buy a basic basket of goods after state support. Its annual increase is then
capped at the growth rate of average earnings plus 2 per cent to stop the LW from rising too fast.
Today’s real LW is in fact £9.08 an hour; it is only set at £7.65 because the cap has been in effect
over recent years.23 The LW will catch up with this real rate over time, held back only by the cap,
meaning it is almost certain to rise faster than earnings for the foreseeable future. This means
that the share of workers paid below the LW will rise steeply. Over the longer term, it also means
that the share of workers paid below the LW can be volatile, being driven by the price of certain
goods and by decisions over state support, neither of which is related to earnings.
These are inevitable weaknesses of any attempt to set an absolute standard for pay as the LW
does. The flipside is that the LW avoids many pitfalls of the standard relative measure of low pay
(two-thirds of median earnings). These pitfalls are familiar from debates about poverty. First,
relative measures are arbitrary; they tell us little about the actual living standards of workers.
Second, relative measures can perform counterintuitively—for example, one way to reduce the
UK’s official share of low paid people is to reduce pay at the median. Third, relative measures of
pay are narrow in scope, ignoring factors such as the price of goods that have a strong bearing on
living standards. For all its weaknesses, the Living Wage has been designed to respond to these
important problems.
23 Hirsch, D. Working paper: uprating the UK Living Wage in 2013, Centre for Research in Social Policy (2013)
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The official relative measure of low pay also has a number of strengths. It compares the fortunes
of the lowest earners with those in the middle, giving a sense of whether earnings growth is
shared across the pay distribution. It is also a relatively simple measure to calculate and explain
as opposed to the LW which as we have seen is in some ways ‘fixed’ to allow for a more
Box 1: Why can’t the government raise the minimum wage to the Living Wage?
The Living Wage campaign itself recognises that the Living Wage should not be mandated
through government policy. Instead, it is clear that the LW is to be pursued through a civil
society campaign in which employers sign up to the LW voluntarily. To understand why
this voluntarist approach is necessary, we need to understand how the LW is set. The
national rate is calculated as follows*:
Focus groups agree on the basket of goods that is needed to live a basic standard
of living in Britain today for nine different types of households
The cost of these baskets is used to calculate the lowest wage a person would
need to earn, working full-time and after taxes and benefits are taken into account,
to pay for these goods. These nine results are then averaged to produce a single
figure.
This figure is in effect the real LW and is known as the ‘reference rate’. In 2013-14 it
is £9.08. However, to prevent the LW from rising too quickly, annual increases are
capped at the growth of average earnings plus two percentage points. In recent
years this cap has limited the ‘applied’ LW to £7.65 an hour. This is the rate of the
LW used by campaigners today.
The formula that is used to calculate the LW has a number of implications. First, because
the applied rate has fallen some way behind the real rate, the Living Wage is now all but
certain to rise 2 per cent faster than average earnings for the foreseeable future as it
catches up. Second, the value of the LW is affected by changes to welfare policy; the LW
rises when state support is cut and falls when state support is made more generous. Third,
because it reflects the cost of a minimum standard of living, the LW is sensitive to the
prices of particular goods. This is inevitable in any attempt to calculate an absolute
measure of living standards like the LW. It does mean, though, that the LW moves largely
independently of wider earnings in the economy.
Together these facts mean that the LW, which already covers at least one in five workers,
is likely to cover a rapidly increasingly share of the UK workforce in coming years. They
also mean that this coverage is volatile. From 2009 to 2012, for example, the share of UK
employees earning below the LW jumped from 14 to 20 per cent while the share below
the official relative definition of low pay stayed relatively flat at just over 20 per cent.
* The London Living Wage is set differently, also taking into account the poverty line and adding a buffer of 15 per cent to reflect the need to save for large irregular costs.
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achievable level. One final upside of relative measures of low pay is that they allow for
international comparisons. Figure 5 shows the share of low pay in OECD economies (focused on
full-time workers for comparability). 24 No country has eliminated low pay but its incidence varies
widely, from 4 to 25 per cent across developed economies. The average share of low pay among
OECD countries is 16 per cent, well below the UK’s share of 21 per cent.
Figure 5: International shares of low pay
Source: Resolution Foundation analysis, OECD stat.
Finally, it is important to note that neither the Living Wage nor the standard measure of low pay
takes into account the persistence of low pay. Recent work by the Resolution Foundation found
that around three quarters of low paid workers fail to fully escape from low pay over ten years or
more, though this has improved over time25. Recent work by Inclusion found that around one in
six workers are in low pay for at least one year.26 While measures of persistent low pay are
inevitably less timely, and so a difficult guide to public policy, reducing the persistence of low pay
is nonetheless an appropriate policy goal.
24OECD Employment Outlook 2012
25 Hurrell, A. (2013) “Starting out or getting stuck? An analysis of who gets trapped on low pay – and who escapes” Resolution Foundation 26Wilson, T. et al (2013) “Work in Progress”, Centre for Economic and Social Inclusion
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2. Options for giving more medium-term clarity over the minimum wage
If the government were to adopt a broader goal on low pay it would allow for a more strategic
approach. But a goal alone would do little without tools to help achieve it. Indeed an ambition
not backed by serious effort could be counter-productive. In the next two sections we consider
how the NMW and LPC could do more to help tackle low pay, asking first how the minimum wage
itself could do more and second, whether the NMW could be complemented with other tools.
When it comes to the NMW itself, we have seen that its relatively short-term and passive
approach was entirely sensible upon its introduction, given the trenchant opposition it faced. We
have learned a number of lessons since then that suggest a stronger approach might now be
possible. Unveiling the NMW just six months before it comes into force creates uncertainty for
business and makes it hard to expect business to plan for a future with less low pay—or indeed
for government to help them. A clearer direction could also make the policy more pro-active,
with the LPC not just recommending the rate but also pointing to blockages that prevent the
minimum wage from being higher (which could range, for example, from the taxes that face small
firms, who struggle most with a higher NMW, to the adequacy of social care funding).
Indicating the future path of the NMW is not an entirely new idea, indeed there is some
precedent from the LPC. From 2001 to 2006 the LPC made two-year recommendations for the
NMW, only switching to one year recommendations as the economic outlook worsened. The LPC
was also asked in 2011 whether more clarity could be introduced. It concluded against the idea,
arguing that: “the disadvantage of constraining the Commission to positions which by definition
cannot be based on timely evidence outweighs any benefit in increased clarity, particularly in the
present uncertain business environment.”27
The LPC is right to say that any longer-term approach to the NMW involves an inevitable trade-
off, sacrificing a degree of independence and flexibility in exchange for more clarity over the
future direction. So how could policy best balance these competing demands?
One option would be to emulate the Bank of England’s forward guidance approach. This could mean asking the LPC to present, alongside its annual recommendation, its central scenario for the medium-term path of the minimum wage. A conservative path would simply follow a forecast for median earnings. The LPC could then be requested to set out the conditions under which a more ambitious path would be followed, from sustained growth in GDP to low or falling unemployment. A more ambitious path could be to raise the NMW relative to median earnings.28 The LPC could also note policy changes that would allow it safely to recommend a higher rate in future. Forward guidance could give employers more clarity that, under certain conditions, they will be
expected to share the benefits of a buoyant economy with their lowest paid workers. It would
27http://www.lowpay.gov.uk/lowpay/report/pdf/8990-BIS-Low%20Pay_Tagged.pdf 28The precise phrasing of this is important. If a forward guidance approach is to strengthen and not weaken the NMW, the LPC
would need to be asked to set conditions in which it would be more ambitious than their default level of ambition. For example, if
the LPC was asked to set out the conditions in which it would raise NMW, or raise the NMW relative to inflation, this would mean
adding a limitation to a process that happens anyway and would, in effect, weaken the current approach.
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also retain flexibility. However, critics have been quick to highlight the downsides of the policy as
undertaken by the Bank of England. The Bank’s need to continually clarify, and then
fundamentally revise, its policy of forward guidance, suggests that this approach might in fact
have little effect.
A stronger option would be for the government to set a clear goal for the future value of the
NMW, with the LPC continuing to advise on the rate each year as well as advising on policy
changes that could quicken progress. This would in effect formalise the Chancellor’s current
approach, while allowing the LPC to respond in a more considered way on the back of research
and consultations. One way to structure this would be for the government to set out its hopes for
the future value of the NMW on a rolling five year basis, while the LPC continues to pass
judgment on the increase that is possible from year to year. In this scenario the LPC might be
encouraged both to recommend the rate and to comment on any blockages to achieving the
government’s ambition. To increase certainty for business, the LPC could also be asked to
recommend not just the rate of the NMW that should come into force in six months’ time, but
also its preliminary thoughts on the rate that should come into force in 18 months’ time.
In important respects this change would make the LPC a more pro-active body. Rather than just
asking whether the NMW has had employment effects, the LPC would ask how the UK could
safely achieve a higher minimum wage over the next five or ten years. The government would set
its medium-term goal for the NMW as a contribution to its wider ambition to reduce the
incidence of low pay. This would undoubtedly represent a shift away from the history of the LPC,
in which its recommendations were made completely separately to government. The danger is of
course that political pressure could push the LPC to recommend rates it otherwise would not
choose, whether higher or lower, politicising what has until now been seen as an objective
process.
A third option would be simply to raise the minimum wage over five years, asking the LPC to
monitor the effects. This would change fundamentally the LPC’s role, turning it into a monitoring
body. The LPC would monitor closely and perhaps more frequently any negative effects and
would advise on steps to ease the transition, for example by raising the gap between the youth
and adult rate, steadily reducing employer taxes for small firms or adequately funding social care.
The benefits of this approach would be to give some confidence to those in low pay that they will
see future earnings increases - which may in turn support consumption in the short-term - and it
would give greater certainty to employers over the likely scale of potential wage pressures arising
from the NMW. But it would come at a very high price. The drawback is clearly that the approach
would undermine the independence of the LPC; it would effectively end the LPC in its current
form.
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Choosing a number?
A major challenge in all of these options is that the government would need to decide on an
appropriate medium-term ambition for the value of the NMW. How could this judgment be
made? Three options would be to:
Raise the NMW to the Living Wage over a number of years;
Restore the value the NMW has lost in the last five years, based on either the CPI or RPI
measure of inflation; or to
Raise the NMW to a set proportion of median earnings, perhaps based on an
international benchmark.
Figure 6 gives an indication of how the value of the NMW would evolve under each of these
options, raising its value over the years from 2013 to 2018. These scenarios should be treated as
highly indicative. They are based on the latest (December 2013) Office for Budget Responsibility
projections for earnings and inflation which themselves are uncertain, with adaptations made for
the likely path of median hourly earnings.29
29OBR Economic Forecasts December 2013
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Figure 6: The future value of the NMW under different ambitions
£ per hour, constant prices CPI-adjusted
Source: Resolution Foundation analysis, OBR and ONS
The first implication of this analysis is that it is unlikely that the NMW could be raised to the Living
Wage in the medium-term (see also Box 1). A more viable option appears to be restoring the
value of the minimum wage to its level in 2008 in real terms, regaining the ground that has been
lost through five successive real terms falls. This is essentially the idea that has been mooted by
the Chancellor. The result depends slightly on which measure of inflation is used.30 Under the CPI
measure of inflation, which does not include housing costs, the NMW would need to be in the
region of £7.40 an hour by 2018-19 in order to restore its lost value. Under the flawed but fuller
RPI measure, under which measure the NMW peaked in 2009, the NMW would need to be in the
region of £7.50 an hour by 2018-19.
Restoring lost ground is clearly an important benchmark. It is easily understood and is likely to
have significant public salience. What this measure does not achieve, however, is any sustained
sense of direction for the NMW once lost ground has been made up. It does not offer a vision for
the future of the NMW beyond getting back to its pre-crisis level. It also fails to take into the
performance of median wages or other worthwhile indicators in the wider economy.
Finally, therefore, we show the path of the NMW if it were to rise to 60 per cent of the hourly
median wage. This is based on a forecast of the median wage adapted from OBR forecasts for
average earnings and should again be treated as indicative. A NMW of 60 per cent of the median
would be at the upper end of international experience. One merit of this approach though is that
it ties the NMW to wider earnings in the economy, a more economically relevant metric than
30 The new RPI-J measure is not yet forecast by the OBR so we are limited to the CPI and RPI measures here.
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either the LW or past values of the NMW. Again, it is worth noting that a relative measure is
necessarily arbitrary. There are lessons to be learned here from the child poverty target,
particularly in terms of how relative targets perform when median income or earnings are
stagnant. It is also worth noting, though, that 60 per cent of the median wage appears to be an
ambitious but plausible level for the NMW. The Chancellor’s recent suggestion of a £7.00 NMW in
2015, for example, would equate to around 57 per cent of the median wage.
Whatever ambition was set for the NMW, the LPC could advise government on policy steps to
help achieve it. Evidence from the first fifteen years of the NMW gives a good sense of which
parts of the economy struggle most when the NMW is raised. These might therefore be priorities
for support to adapt:
- Social care: early studies into the effects of the NMW found some evidence of reduced
employment from the NMW in small, low paid care homes.31 There is a clear link here to
flexible and responsive social care funding that is adequate to cover the NMW.
- Young workers: while there is no consistent finding of statistically significant
employment effects, studies have tended to find larger effects on younger workers. A
higher adult rate could in theory be combined with an increased gap between the adult
and youth rates.
- Small employers: firms with fewer than 10 employees face a larger wage-bill effect from
a higher NMW than larger firms, and may be worth targeting through reduced employer
taxes.32
- Female part-time workers: there is some evidence of reduced hours of work among
female part-time workers, where the level of the NMW is high relative to earnings. This
might justify, for example, targeted skills interventions.
3. Options for strengthening the LPC with additional tools
In the third and final section of this chapter we consider whether extra powers or responsibilities
could be given to the LPC to complement the impacts of the NMW. Whatever the Government’s
level of ambition, the minimum wage will only ever be one of several tools needed in the battle
against low pay. Some of these tools, from education and skills to industrial strategy, will fall to
other areas of Government. But the LPC may be well-placed to lead on others.
One reason for thinking that additional tools will be needed is that any single, mandatory NMW
will always be limited by a basic constraint: it has to be set with an eye on the most vulnerable
part of the labour market. While we have argued above that a higher NMW might be possible if
this goal was actively supported by wider government policy, the NMW will always be a blunt
tool. Indeed, there may be good reasons to avoid a world in which the NMW covers a very large 31 Machin, S., Manning, A. and Rahman, L. Where the minimum wage bites hard: the introduction of the UK National Minimum Wage to a low wage sector, London School of Economics (2002) 32 Resolution Foundation, forthcoming
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share of workforce; an alternative aim would be to find new ways to push employers to go
further than the NMW, where they could afford to do so, inserting new pressures points into the
system. As the Living Wage campaign has shown, some of these roles fall to civil society, pressing
employers to pay more than their legal obligation. But there may also be ways in which the LPC
could inform these debates, drawing on its expertise and authority.
Figure 7 highlights the uneven spread of low pay by sector. More than four-fifths of all the UK’s
low paid workers are found in just 14 sectors. This presents both opportunities and challenges.
Small improvements within these sectors would have big impacts. It also means that, in most
sectors, low pay makes up a small share of the workforce and a higher wage-floor would have a
small impact on wage-bills. Collectively these sectors contain a large number of low paid workers,
and could very likely afford to pay them more.
Figure 7: Distribution of low paid workers by sector
Source: Resolution Foundation analysis, Annual survey of hours and earnings
Sectors are of course not the only way in which low pay varies. Regional disparities, particularly
between London and the rest of the country, are striking. While the high cost of living in London
suggest that a higher minimum wage would be merited, doing so without reference to the labour
market may be unwise. Recent research does suggest, however, that had it been asked to
recommend a minimum wage for London, the LPC would likely have set a higher rate for the
capital.33
Publishing ‘reference rates’ might be one way in which the LPC could put its authority and
legitimacy to good use while not departing from the analytical, labour market focus of its current
33 Ussher, K. London rising: The case for a London minimum wage, Centre for London (2013)
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work. These suggested rates for what would be ‘affordable,’ taking into account wage bills,
profits, firm size and any other relevant factors, would introduce new pressure points without
setting additional mandatory minimum wages. They would also allow campaigns such as the
Living Wage to use the LPC’s reference rates as part of a push for better wages where affordable.
This could be one route to generating some upward pressure in sectors that can afford it without
going down the burdensome and bureaucratic path of having varying mandatory minimum wages
in different sections of the economy.
Any decision to give the LPC additional tools would not need to be implemented overnight. It may
be that the LPC could in time, and subject to initial forays into extra roles, carry out a range of
other tasks to help support a government objective on low pay. There is also a legitimate
question as to whether such work would fall to the nine-member panel of the LPC itself, or to the
secretariat of a broader body in which this Minimum Wage Panel would sit. There are arguments
on both sides. On the one hand, securing buy-in from social partners for action on low pay would
give authority to the recommendations. On the other hand, this would substantially broaden the
LPC’s discussions and could risk overloading the body and could put at risk its fundamental role of
setting the NMW in a consensual, evidence-based way. At a minimum the new body would need
to be better resourced.
Summary and next steps This chapter has put into practice the lessons learned from other bodies involved in economic
policy. Rather than settling on any particular reform, it has set out a range of options for a
broader, more assertive and more confident approach to the minimum wage and low pay.
Of course there are risks and rewards involved in any reform of the minimum wage. But it does
seem that there are practical ways to strengthen the LPC while preserving many of the strengths
of the current settlement. This discussion paper has talked through some of the options. The final
report of the Resolution Foundation’s review of the future of the National Minimum Wage and
Low Pay Commission will be published in March 2014.
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Annex 1 – Low Pay Commission Terms of Reference
The Purpose of the Low Pay Commission
The Low Pay Commission (LPC) is an advisory Non-Departmental Public Body, established under
the National Minimum Act 1998. Its purpose is to provide independent advice to the
Government on matters relating to the National Minimum Wage (NMW), referred to it by the
Secretary of State for Business, Innovation and Skills (BIS).
The Aim of the Low Pay Commission
The aim of the LPC is to recommend levels for the minimum wage rates that help as many low-
paid workers as possible without any significant adverse impact on employment or the economy.
The advice the LPC offers the Government, in pursuit of this aim, will be based on the best
available evidence.
The Commissioners
The LPC will consist of a Chair and eight other Commissioners, who will be appointed by the
Secretary of State for BIS. Commissioners will be appointed in accordance with the Code of
Practice for Ministerial Appointments to Public Bodies issued by The Commissioner for Public
Appointments.
The LPC will have a balance of Commissioners who have a knowledge, experience or interest in:
trade unions or matters relating to workers; employers’ associations or matters relating to
employers generally; and independents, with other relevant knowledge or experience, for
example academic experts in labour markets.
The Operation of the Low Pay Commission
The LPC will publish a Business Plan each year. The Business Plan will include details of its remit,
key milestones, research programme, and resources allocated to fulfil its function. The Business
Plan will be published on the LPC website.
The LPC will be advised of issues it is required to consider by way of a remit from the Government
(usually annually). The LPC will discharge the remit by way of a report, which will be submitted to
the Government within the prescribed timetable.
In considering the issues in the remit, the LPC will undertake a detailed analysis of the evidence
before making any recommendations, and it will take an open and consultative approach to its
work. The information that informs the LPC’s considerations will be gathered through wide-
ranging research and consultations, including visits, discussions with businesses, workers,
representative bodies, Government and academics. In reporting to the Government, the LPC will
detail the procedures it adopted in respect of any consultation, taking evidence and receiving
representations, along with the reasons for its recommendations.
The quorum for formal meetings of the LPC will be five Commissioners, including at least one
independent, one employer and one employee Commissioner. If the Chair is absent for any
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formal meeting, one of the independents will chair proceedings. For visits and other meetings,
the quorum will be as decided by the Chair.
Further details concerning the operation of the LPC can be found in the Code of Conduct. These
Terms of Reference will be reviewed periodically.
The Resolution Foundation
The Resolution Foundation is an independent research and policy organisation. Our goal is to
improve the lives of people with low to middle incomes by delivering change in areas where
they are currently disadvantaged. We do this by:
- undertaking research and economic analysis to understand the challenges facing people
on a low to middle income;
- developing practical and effective policy proposals; and
- engaging with policy makers and stakeholders to influence decision-making and bring
about change.
For more information on this Briefing Note contact:
James Plunkett, Director of Policy
020 3372 2956